May 7, 2008
Seven habits finance regulators must acquire
By Martin Wolf
Paul Volcker is the giant among contemporary central bankers, both literally and figuratively. He it was who had the moral courage to crush inflation as chairman of the Federal Reserve between 1979 and 1987. When Mr Volcker speaks, people listen. What he had to tell the economic club of New York last month was well worth listening to. His summation, cited above, was so devastating, because so true.
Mr Volcker noted that this crisis is not unique. On the contrary, “today’s financial crisis is the culmination, as I count them, of at least five serious breakdowns of systemic significance in the past 25 years – on the average one every five years. Warning enough that something rather basic is amiss.” Those who do not heed such warnings are fated to suffer something yet worse.
So what is to be done? There is a part of me – quite a large part, in fact – that says: “Forget regulation: it will never work. Apart from normal laws against fraud, let the financial system live and die by the laws of competitive markets. If businesses fail, let them simply go down, with all their shareholders, customers and employees. Meanwhile, we will remind users constantly of the dangers.”
The remainder of this column can be read here. Debate from our panel of economists appears below.
Eric Lonergan: I am struck by one of Volcker’s statements you quote: “it is hard to argue that the new [financial] system has brought exceptional benefits to the economy generally”.
Is this true?
People forget that the subprime mortgage market is almost 15 years old. Millions of poor Americans and immigrants are homeowners as a consequence.
The “originate and distribute” model is, of course, not new for financial markets in the aggregate (the stock market is an originate and distribute model, so is the corporate bond market); the innovation has been in extending this model to a broader class of debt instruments. The benefits of the diversification of risk associated with this have been huge - no major US bank went under during the last recession (or even came close) despite the major bust in leveraged telecoms companies, precisely because the debt was distributed and diversified globally.
The costs of the current “crisis” also look remarkably low both in economic and fiscal terms. It is too early to make a verdict on the US economy, but so far the weakness is considerably less than anyone (including Roubini) forecast, or would have expected, given the extent of the housing recession and the level of the oil price. The financial sector fallout, moreover, has had minimal fiscal impact compared to the Savings and Loans crisis - which was a very old fashioned banking crisis. Sor far, all the costs of recapitalisation have been borne by the private sector (or sovereign funds - who are part of the new global financial structure). The only Federal govt “cost” is the Fed’s assumption of some of Bear Stearns risk, which is over-collateralised and unlikely to result in any loss.
Finally, is it really plausible that there is no link between financial innovation and higher US productivity growth in the last 15 years and the declining volatility of financially liberalised economies over the last 20 years?
This crisis will still prove to be highly functional; primarily in teaching all relevant parties (investors and regulators) more about the risks associated with these beneficial innovations. That is historical pattern of financial evolution.
Posted by: Eric Lonergan, Hedge Fund Manager, M&G | May 7th, 2008 at 4:26 pm | Report this comment